Expert Interview: Don’t Ignore Smaller Stocks
Under current market conditions, you ignore small- and mid-cap stocks at your peril, especially those in the technology sector. I discussed this topic with my colleague Nathan Slaughter, chief investment strategist of Takeover Trader and High-Yield Investing. That’s Nathan, to your left. My questions are in bold.
The stock market rally since the pandemic lows of late March has been driven by a handful of technology sector behemoths. What about the smaller tech firms?
Look, it doesn’t take a top-notch market expert to see what led the market on a furious rally in the aftermath of the COVID-19 selloff. In fact, you can’t help but notice that they happen to belong to the same sector.
I’m talking about names like NVIDIA (NSDQ: NVDA), Advanced Micro Devices (NYSE: AMD), Amazon (NSDQ: AMZN), PayPal (NSDQ: PYPL), and others. Those names, by the way, happen to be four of the top-five performers in the S&P 500 this year.
The tech group has absolutely dominated the market this year. Apple (NSDQ: AAPL), Netflix (NSDQ: NFLX), Adobe Systems (NSDQ: ADBE), and Salesforce (NYSE: CRM) are also in the top 10.
Keep in mind, that’s just within the realm of the S&P 500, home to the nation’s largest publicly traded businesses. While these S&P 500 heavyweights account for 80% of the market’s girth, they are only a fraction of the 7,000+ stocks trading on major U.S. exchanges. If you ignore the other 6,500, you’re leaving big money on the table.
When it comes to market-beating smaller stocks, many are riding COVID tailwinds. Not all of them are strictly in the technology realm. Coronavirus vaccine hopes have made it a good year for biotechs such as Adaptimmune Therapeutics (NSDQ: ADAP), while social distancing mandates are benefiting companies like Nautilus (NYSE: NLS). With more people exercising in their homes these days, shares of the fitness equipment maker have soared seven-fold.
But these two small-caps haven’t kept pace with Waitr (NSDQ: WTRH), which has spiked more than 1,000%. Clearly, this is a good time to be in the food delivery business. The company has just added grocery and alcohol delivery to its service repertoire, which are big potential growth drivers.
What about mid-cap stocks? They’re defined as stocks with market caps between $2 billion and $10 billion. They also have a lot of appeal right now, don’t they?
Yes indeed. Within the mid-cap space, the top performer is Novavax (NSDQ: NVAX), a frontrunner in the race to develop a COVID-19 vaccine. The stock has delivered a jaw-dropping gain in excess of 2,000% this year.
Other big mid-cap winners include Fastly (NSDQ: FSLY), a provider of cloud computing infrastructure, Fiverr International (NSDQ: FVRR), which runs an online marketplace for professional freelancers, and Overstock (NSDQ: OSTK), an Internet retailer.
What am I getting at here? Well, for starters, don’t be afraid to invest in smaller companies that aren’t yet household names. The top-performing small and mid-sized companies have been outrunning large-cap winners by as much as a 10-1 margin.
That’s a bit surprising, considering the Russell 2000 Index has lagged behind the S&P 500 by about 14% this year.
Second, the market is clearly separating winners from losers in this new COVID world. Those tailwinds I mentioned earlier might not be fading away anytime soon, even with a potential vaccine on the horizon. In fact, many of our forced lifestyle changes may prove to be permanent (telehealth, for instance).
And that’s exactly why this pandemic is seismically reshaping the investment landscape, toppling some industries and thrusting others higher.
But the tech sector as a whole is overvalued. Shouldn’t investors remain wary of tech stocks?
Only as it pertains to the overvalued giants. The sector currently is home to many bargains in the small- and mid-cap space.
If you don’t have any exposure to the tech sector, then your portfolio is probably hungry for gains this year. Sure, the market has also been feasting on anything with either “immune” or “therapeutics” in the name. But a high-tech diet has been the surest way for investors to stay well-fed.
Apple, Facebook, and Amazon may have led the charge to record highs, but many of their smaller counterparts are doing even better and they’re more attractively priced.
Plus, there are sound reasons why the investment community continues to propel these stocks upward. Even in the face of a global pandemic, many tech companies continue to post record earnings. Apple generated an unprecedented $16 billion in operating cash flow last quarter, with all 510 retail stores completely shut down, and dished out $3.5 billion in dividend payments.
According to FactSet Research, 94% of tech companies beat earnings estimates last quarter, tops among all sectors. Nearly two dozen have already released positive third-quarter guidance, also the highest of any sector. And the group as a whole is forecast to hike dividends by an average of 9%, trailing only the 10% for health care stocks.
Meanwhile, entire sectors of the economy (such as real estate, consumer discretionary and energy) are underwater in 2020.
Just look at the T. Rowe Price Equity Income Fund (PRFDX), a portfolio anchor for thousands of 401k holders and other investors. The dividend-centric fund invests strictly in a diversified pool of undervalued stocks with generous payouts. Its $15 billion portfolio is heavy in banks, health care firms, industrial manufacturers, and other income producers, but noticeably underweight tech.
Year-to-date, PRFDX is down more than 15%, the worst showing in over a decade. I suspect the fund will return to its winning ways in time. Still, it might continue to lag without more help from Silicon Valley. And that goes for you and me as well.
Editor’s Note: Nathan Slaughter has just provided you with invaluable investment advice. But this interview only scratches the surface of the expertise on our team. Consider our colleague Dr. Stephen Leeb, chief investment strategist of The Complete Investor.
America faces what my colleague Dr. Leeb calls a “reset” of our economy that will revolutionize the way we work, save and invest. Advanced technologies are coming to the fore that will usher in a world that you’ll barely recognize. To not only survive but also thrive during this reset, you need to pick the right investments.
Through painstaking research, Dr. Leeb has identified one company that he estimates could appreciate more than 300% in the coming years. For details, click here for our special report.